Page 133 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 11 : Balance of Payments and Balance of Trade : Meaning and Components

Notes
4. Long Term Capital Account 150 120 + 30
C. BASIC BALANCE (1 + 2 + 3 + 4) (750) (670) (+ 80)
5. Short Term Capital Account 50 40 + 10
D. BALANCE OF PAYMENTS ON
CAPITAL ACCOUNT (4 + 5) (200) (160) (+ 40)
E. OVERALL BALANCE OF
PAYMENTS (B + D) (800 (710) (+ 90)
6. International Liquidity Account
Net Changes in External Reserves 90
F. BALANCE OF PAYMENTS
ACCOUNTING BALANCE (800) (800) (0)

In Table 3, the six accounts are numbered from 1 to 6, whereas the major BOP concepts are serialized
as A, B, C, D, E and F. Using this table as the basis we shall now study the BOP concepts.
11.3 Meaning of Balance of Trade

Balance of trade may be defined as the difference between the value of goods and services sold to
foreigners by the residents and firms of the home country and the value of goods and services
purchased by them from foreigners. In other words, the difference between the value of goods and
services exported and imported by a country is the measure of balance of trade. If the two sums
(1) value of exports of goods and services, and (2) value of imports of goods and services are exactly
equal to each other, we say that there is balance of trade equilibrium or balance; if the former exceeds
the latter, we say that there is balance of trade surplus; and if the latter exceeds the former, then we
describe the situation as one of balance of trade deficit. Surplus is regarded as favourable and deficit
as unfavourable. In Table 3, there is a balance of trade deficit equal to $130 million.
The readers are warned about the use of terminology. The balance of trade definition adopted above,
is that of James E. Meade — a Nobel Prize British economist, W.M. Scammel also prefers to adopt
Meade’s definition of balance of trade. But some writers however define balance of trade as the
difference between the value of merchandise (or goods) exports and the value of merchandise (or
goods) imports, making it the same as the ‘good balance’ or the ‘balance of merchandise trade’. There
is no doubt that the balance of merchandise trade is of great significance to the exporting country; but
of still greater significance is the balance of trade defined in Meade’s sense (i.e. to lump goods and
services balance together). In the familiar macro-economic equation y = C + I + G + (X – M), the
expression Net Exports (or X – M) denotes the balance of trade in Meade’s sense. Balance of trade is
a national income injection and for that reason, it is better to use Meade’s concept of balance of trade.
Equating balance of trade with goods balance alone is to ignore the importance of service balance as
a factor in determining national income.
In case of countries like Malaysia, goods balance is always favourable but service balance is always
unfavourable. According to Meade’s definition of balance of trade, Malaysia will have a consistent
balance of trade deficit; but if we use the other (and more commonly used) definition of balance of
trade (synonymous with goods balance alone) then Malaysia’s balance of trade will be one of consistent
surpluses. Malaysian government itself uses this more commonly used definition of balance of trade
and not the one given by Meade. In our Table 3 we have balance of trade surplus of $20 million using
the more commonly used definition of trade balance; but if we adopt Meade’s definition, there is a
balance of trade deficit of $130 million. If any case, before coming to any conclusions on balance of
trade surpluses and deficits in a given country, we must first make sure what definition of balance of
trade is adopted in that country.
Regardless of which definition is adopted one thing is certain, viz, that balance of trade is a national
income injection; and hence it is appropriate to regard an active balance (i.e. an excess of credits over
debits) as a desirable state of affairs. Should this then be taken to imply that a passive trade balance

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